Three Factors That Trigger Meltdowns in Emerging Markets’ Currencies
Several currencies in emerging markets have suffered recent downfalls since Turkey was hit by a financial crisis last month. The trend of weakening currencies has reverberated across countries from South Africa to Indonesia.
Argentina entered an emergency phase in August and the country’s central bank hiked rates to 60 percent from 45 percent. The country’s central bank said it would not lower rates at least until December. Inflation in the country is expected to rise to 30 percent from the current standing (23.17 percent).
The Argentine Peso has also dropped more than 45 percent this year so far. The Mauricio Macri administration is going so far as to cut the numbers of ministries in his cabinet to save the state budget.
On Wednesday, the Indonesian Rupiah closed at Rp 14.938 per the U.S dollar, a 0.02 percent fall. The Indian Rupee weakened 0.22 percent to 71.72 against the greenback.
The pressure on the Rupiah in 2018 is not as drastic as what happened in 1998 when the Rupiah was Rp 2.800 to the U.S dollar and then slumped to Rp 14.000. According to Ahmad Erani Yustika, the Indonesian President’s Special Staff, all the economic indicators 20 years ago were underperforming when inflation hit 82.4 percent. The political situation also played a role at that time which led to the collapse of the New Order regime under Soeharto.
But why are emerging markets’ currencies tumbling?
The increase in the Fed benchmark rate: One of the factors that put pressure on emerging markets’ currencies is the Federal Reserve’s policy that has increased the benchmark rate in the past few months, attracting investors and making them pull out their money from emerging markets.
The rise in the benchmark rate has helped to boost the greenback up by 3.3 percent this year against the Turkish Lira and the Argentine Peso. The situation threatens companies in Turkey and Argentina who save credits in the U.S dollar.
The Federal Reserve benchmark rate is defined as the rates charged by banks to one another to lend Federal Reserve money overnight. The U.S. central banks use the rate as an instrument to monitor and control the country’s economic growth.
The trade war between the U.S and China: The U.S.’ threats to impose a tariff on imported products from China worth $200 billion is also worsening the situation.
“A broad-based increase in tariffs worldwide would have major adverse consequences for global trade and activity,” The World Bank stated in its latest economic outlook, released in early June.
The U.S is also waging a trade war with Turkey by raising tariffs on imported steel and aluminum. Both countries’ relationship has strained as Turkey refused to extradite an American pastor who was accused of having ties with terrorism-related groups that tried to topple Turkish president Recep Tayyip Erdogan.
FXTM Research Analyst Lukman Otunuga said in Jakarta that prolonged trade tension in the global economy and the rise in the U.S. economy creates fear in emerging markets.
“More pain seems to be ahead for emerging markets as the combination of global trade tensions, prospects of higher U.S. interest rates and overall market uncertainty haunt investor attraction,” he said.
Dependence on foreign funding
While reasons for the collapse of currencies in Argentina, Turkey, and South Africa may vary, there is one thing they have in common. All three countries are heavily dependent on foreign assistance.
The total amount of loans in all developing countries skyrocketed from $21 trillion in 2007 to $63 trillion in 2017, 200 percent higher than their GDP, as the IMF estimated.
According to economist Satyajit Das, as quoted by Indonesian newspaper Tribunnews, countries with debt-to-GDP ratios between 20 percent and 50 percent are South Africa, Mexico, Chile, Malaysia, Brazil, and some Eastern European countries. Surprisingly, Lebanon has the third largest debt-to-GDP ratio (149 percent).
Foreign ownership of state bonds in Indonesia jumped from 33 percent in 2014 to 40 percent in 2017.
Corporate debt in developing nations is bigger than it was before the 2008 global crisis. The bigger the volume of the debt is, the more severe the risk they are facing.
“The risk is increasing in those countries,” Bertrand Delgado, director of global markets for Societe Generale in New York, warned.